Kuroda Will Be the 'Carlos Ghosn' of the BOJ
Japanese Prime Minister Shinzo Abe has nominated Haruhiko Kuroda, the current head of the Asian Development Bank, to be the new Bank of Japan (BOJ) Governor. This is a bold move that should allow Japan to press the "reset" button on its monetary policy.
I believe he's likely to succeed where other BOJ governors have not and make some progress in defeating deflation. At least, he should make some progress in weakening the yen. Here's why.
Kuroda has been a long-time critic of the central bank's monetary policies throughout his career in the finance ministry, in academia and in his current position. He wrote a book titled "Success and Failure in Fiscal and Monetary Policy" in which he blames the BOJ for a variety of monetary mistakes ranging from being too accommodative during the Bubble Era of the late 1980s to being too restrictive in the early part of this century.
(Read More: Kuroda Signals Aggressive Monetary Policy Coming)
One of the newly nominated deputy governors, Professor Kikuo Iwata, goes even further. A professor of economics at Gakushuin University, he has been a consistent critic of the BOJ since the early 1990s, when he engaged in a public debate with a senior BOJ official over monetary policy in a respected Japanese economic magazine. Just last year he published a book entitled "The Guardian of Deflation," his disparaging nickname for the BOJ. He recently declared that "the BOJ needs a regime change."
That drive for "regime change" is the main reason I think these two may succeed. All organizations have a "house view," a consensus that develops over time on how to deal with problems. Of course there are internal debates, and the BOJ, with outsiders sitting on its Monetary Policy Board, probably has more such debates than many other institutions. Yet there has been a consistent official view that deflation cannot be defeated by monetary means. And changing the "house view" in Japan is even more difficult than changing it in other organizations.
The problem is the role that continuity and precedent play in the Japanese bureaucracy. According to the late Japanese psychiatrist and cultural critic Dr Masao Miyamoto, "continuity is the most important concept for the bureaucrats." That's because changing policy is tantamount to saying that the people who set policy before were wrong, and that just isn't done in a hierarchical organization where one's career can depend on the help of those who are more senior to you.
The left hand column is the ratio between BOJ's balance sheet and the Fed's, while the right hand column tracks the corresponding USD/Yen movement.
Change of Course
"The status quo in the Japanese bureaucracy is labeled as precedence and one should always respect precedents that have been set," is the way Dr. Miyamoto explained the way of thinking at the Ministry of Health and Welfare, where he worked in the 1990s.
The official BOJ line for years has been to downplay the effectiveness of quantitative easing and to play up the risks, as the outgoing BOJ Governor, Masaaki Shirakawa has done. It would be "difficult" (Japanese for "impossible") for a career BOJ person to alter the narrative that has dominated the central bank's thinking for so many years.
The problem isn't just in the government. Look at Nissan Motor, for example. The company lost money for seven out of the previous eight years before Carlos Ghosn took over in 2001, but has been profitable ever since, except for the year of the financial crisis.
A lot of what he did to turn the company around wasn't particularly special; it didn't take a management genius to figure out that cutting the number of suppliers in half might save money, or that there might be better use for the firm's capital than holding stock in 1,394 companies.So why didn't it happen before? Because an insider could never have taken the decision to cut 14 percent of the workforce or sell off prized assets. Such an assault on continuity and precedent would be inconceivable in the traditional Japanese context.
As outsiders coming into the BOJ, it'll be easier for Kuroda and Iwata to say "we were wrong" and to change course. In fact they've already said the BOJ is wrong, so the next step is pretty clear.
What the Bank of Japan does is of crucial importance to forex traders, because at certain (but not all) times there's been a fairly good relationship between the relative size of BOJ's and the Fed's balance sheets and the U.S. dollar/Yen pair.
The relationship makes intuitive sense, because when one central bank's balance sheet is growing relative to another's, it means that the first central bank is expanding the supply of (base) money faster than the other central bank.
An increase in the relative supply of money should cause a decrease in relative price over time, all other things being equal.The relationship held fairly well from the late 1980s to the mid-1990s. As the first graph shows, it also held moderately well from 1998 to 2002. It broke down for a few years after that, but the second graph shows that it's come back since 2009.
The recent divergence, circled in the second graph, is particularly intriguing: it suggests to me that the market is already discounting a surge in the size of the BOJ's balance sheet relative to the Fed's. I expect that Kuroda will be the "Carlos Ghosn" of the Bank of Japan and that the U.S. dollar/yen is likely to move still higher as a result.
The author is the Head of Global FX Strategy at IronFX, an on-line trading firm specializing in Forex, CFDs on U.S. and U.K. stocks, and commodities. He was previously Head of the Forex Committee at Deutsche Bank Private Wealth Management.